Workers must get a bigger slice of the pie

Economic growth in Europe depends on a recovery in household consumption. And that, in turn, requires a rethinking of the balance between capital and labour.

Over the last 30 years, wage growth has lagged behind productivity across the industrialized world, leading to a steep fall in wages, salaries and other employee benefits as a proportion of GDP.

Simultaneously, there has been a big rise in inequality as the benefits of economic growth have accrued to those at the top of the income scale, as well as a steady increase in corporate income and profits. These trends have gone hand-in-hand with a steady decline in business investment.
Europe’s strategy for dealing with the euro zone crisis has exacerbated these trends and is therefore a further obstacle to economic recovery.

European countries are relying on two things to boost investment and hence employment:
First, they are trying to lower labour costs, make their business environments more attractive by switching the burden of taxation from the corporate sector to the consumer, pushing through labour reforms aimed at reducing workers’ bargaining power and curtailing social rights and transfers. Second, they are attempting to boost business confidence by consolidating public finances.

Such a strategy might make sense for individual countries, so long as they can rely on exports, but not for the European economy as a whole. The strategy promises to further aggravate Europe’s core problem — a structural shortage of demand — by bringing about a further decline of labour income and a further rise in inequality.

There is no doubting the need for reforms aimed at increasing competition and opening the way for the adoption of new technologies. But governments need to combine market-led reforms with measures aimed at preventing a further decline in labour’s share of the pie.
With households now highly indebted across the industrialised world, a sustained recovery in private consumption will require a rise in the share of national incomes accounted for by wages and salaries.

There are a number of things governments can do. But some will require them to challenge firmly held assumptions, to work more closely together and to distance themselves from special pleading by business.

•There is some evidence that raising skills levels can combat inequality, and governments should certainly redouble their efforts to reduce the number of people who leave school early. But even countries that have well-trained work forces have experienced sharp falls in labour share and rising inequality. 

•Executive remuneration needs to be linked to long-term performance, and not just to the share price. Executives’ duty should be to the company, its long-term health and those who work for it. This would encourage a greater emphasis on long-term organic growth (as opposed to expansion through mergers and acquisitions) and lower the excessive focus on reducing labour costs. The relationship between risk and reward must be rebuilt by reducing executive remuneration.

•Tax systems need to be more redistributive. The better-off need to pay more tax; those on lower incomes need to pay less. In tandem, governments should switch the burden of taxation from consumption to capital by reducing value-added taxes and increasing taxes on capital and wealth. There is no empirical evidence that this would hit investment or work incentives. In an effort to address beggar-thy-neighbor tax competition, the European Union should move to harmonize corporate tax bases and rates.

•Countries need to end their obsession with “competitiveness.” Competitiveness is relative; countries cannot all return to growth by becoming more competitive relative to one another. The policies employed to boost competitiveness threaten a further decline in labour share and rising inequality. Instead of competitiveness, European governments should be focused on boosting domestic demand. This will require expansionary macroeconomic policies. Monetary policy should be loosened further, and the European Union as a whole needs to put an end to fiscal austerity.

•Finally, governments should adopt a more skeptical ear when confronted with business lobbying. What might work for individual firms is at best zero-sum when adopted by countries.

For their part, the leaders of finance and business need to recognize that their remuneration is an obstacle to the kinds of market-led reforms that they themselves advocate and that are needed to boost economic performance.

What will happen if governments fail to change track? Economic recovery will prove elusive and public finances will remain chronically weak. This will exacerbate the legitimacy problems of markets, weaken social cohesion and undermine political effectiveness.

Voters will associate structural reforms with declining living standards, increased insecurity and inequality. Not only will governments struggle to push through the needed reforms, but there will also be a risk of a broader backlash against the market economy and the European Union.
Mainstream political parties are likely to lose much of their credibility, and euro-skepticism is likely to take hold as more populist politicians respond to mounting popular anger by becoming increasingly hostile to the European Union. Support for state control over capital is likely to rise as are demands for greater trade protectionism and tougher curbs on immigration.

These are unlikely to prove transient trends: Events of this kind tend to influence attitudes for decades.